Stock Review

Jan 29, 2013

Argan (AGX) is a small holding company with two consolidated subsidiaries. By far the largest is Gemma Power Systems (GPS), which accounted for close to 95% of sales and gross profits for the first 9 months of this fiscal year ending in January. Gemma is involved in the planning, construction, renovation, and maintenance of power production facilities. The smaller subsidiary is Southern Maryland Cable (SMC), at less than 5% of sales and profits. SMC contracts jobs for telecommunications installations, including indoor wiring and equipment installation and outdoor jobs requiring buried cable.

Gemma's specialty is in the engineering and construction (E&C) of natural gas and wind power plants. I believe this is a good place to be going forward. We are in the early innings of a long-term migration to cleaner and safer sources of energy. Natural gas is a cleaner alternative to coal and is in huge abundance in the U.S. with recent advancements in "fracking" extraction techniques. Nuclear, which provides about 20% of all power in the U.S., received a huge black mark with the 2011 Fukushima Daiichi disaster in Japan, and now has 20 major nations pledging a phase-out. There should be plenty of work in the future for Argan's services.

Further cases can be made for an investment here by pointing to the financial position and valuation of the stock. Argan is in good health, with almost $200 million in cash and no debt. The cash alone represents 72% of the company's $273 million market valuation! At just over $19, Argan stock has a Magic FormulaŽ adjusted earnings yield of 17%, far cheaper than competitors like Fluor (FLR) or Foster Wheeler (FWLT), both at 10%. Certainly, there are worse picks than a small company trading cheaply against past earnings with a debt-free balance sheet and solid opportunities for growth.

To be clear though, this is a highly speculative stock. The main problem I have with the company is one familiar to many small-cap stocks: intense customer concentration. Gemma's backlog stands at $236 million, but 90% of it is tied to two projects: the CPV Sentinel project (an 800MW nat gas power facility in California), and a 50MW biomass-fired power plant in Texas. The CPV construction is set to finish this summer, while the Texas project completes at the end of 2014.

This means, of course, that Argan needs to start thinking about re-filling the pipeline.

To that end, Argan is taking action. It has invested around $5 million in loans to Moxie Energy to develop two gas-fired power plants right on the shale, eliminating transport costs (a logistical issue with nat gas) and supplying electricity to the crowded northeast power grid. Under the development agreement, Argan gets the right from Moxie to provide the E&C services for the plants, should they go forward. This could be a big deal for Argan - the combined capacity of the Moxie plants will be more than the combined output of Sentinel and Texas. Those two together were worth over $360 million in revenue.

At this point, it seems that both plants are in good shape to move forward. Here is an excellent recent write-up on the situation (and the company).

New awards volume beyond that are anyone's guess. The U.S. is in a period of stagnant power demand, and strapped government budgets could force them to cut wind power subsidies. Given the few available jobs, larger competitors have been aggressive on price. As such, I (and management) do not expect a lot of big new wins in the near term. But this is tough to predict.

E&C firms are always tricky to value, and Argan especially so given its tight concentration of business and numerous risk factors. Assuming the Sentinel and Texas jobs deliver as planned, and assigning a reasonably high likelihood of Moxie contributing as expected, I see Argan as worth about $20 over the long term... not much over the current stock price. We'll slap the "neutral" tag on this one - there are better opportunities in Magic FormulaŽ Investing at present.

Company Description

Argan, Inc. provides consulting, engineering, procurement, construction, commissioning, operations and maintenance services to the power generation and renewable energy. The company provides services to the telecommunication, public utilities, power, municipalities, and public and private industries. The company operates through its subsidiaries Gemma Power Systems and Southern Maryland Cable. The Gemma Power Systems is a power plant designer and builder with expertise in engineering, design, procurement and construction. The company excels in developing traditional natural gas power plants as well as alternative fuel projects including biodiesel, ethanol, and other renewable energy sources such as biomass, wind and solar. The Southern Maryland Cable provides comprehensive technology wiring and utility construction solutions. The company furnishes inside premise wiring services to the federal government, including military installations and government office sites requiring high-level security clearance, and underground and aerial construction services and splicing to utility, telecommunications, construction and local government customers. The company was founded in May 1961 and is headquartered in Rockville, MD.

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